Business blood bath not far away

Average businesses are facing significant headwinds… and are losing the battle.

The South African private sector is in deep trouble. The average South African business is on its knees and barely keeping the lights on.

In fact, the perpetual decline in economic activity of the past few years has eroded the profitability of the average local business to such an extent that business owners would earn more on their capital putting their money in a bank, than continuing fighting the entrepreneurial battle.

I am not talking about the big JSE-listed companies that seem to perform well despite the depressed economic environment. I’m referring to the thousands of small- and medium-sized businesses that represent the mainstay of the South African economy. It is this sector that employs the most workers and is a key source of social stability.

The powers that be should appreciate the predicament these businesses find themselves in.

Not only is red tape and regulation, which puts a heavy burden on many South African firms a problem, the cost of capital is more than most firms will earn on their ventures. Operational costs in South Africa – such as electricity, water and labour costs – have risen above the inflation rate to levels that make many firms unsustainable.

Now that incomes are under pressure from lower growth and sinking commodity prices, firms can no longer afford to have large cost burdens. Profit margins and returns are declining to a point where, for the average private sector firm, continuing operations is not done for financial reasons.

Statistics South Africa’s (StatsSA’s) financial surveys clearly show that numerous businesses are on the proverbial precipice – and any further headwinds may force many businesses to close their doors or to scale down operations.

Urgent intervention is needed, such as curbing the stranglehold trade unions have on the private sector, as well as policy certainty and consistency in various industries. Even more importantly, the business sector needs to believe that government is pro-business and that verbal commitments are followed up with pro-business policies.

It is within this context that government should look at the health of the business sector.

The most alarming statistic is that the average return on assets has nearly halved, from 8% in 2012 to a paltry 4.8% in the first quarter of 2016. “This shows the amount of pressure on businesses today,” says Mike Schüssler of Economists.co.za. “If businesses had left their money in the bank, they would have made more money. It is also less risky and requires less effort,” says Schüssler.

With money market interest rates of 7%, it is not surprising that companies are keeping cash reserves in the bank and not investing in new ventures. Some estimates even put total cash holdings north of R800 billion.

The 4.8% return on assets number is collaborated by a sharp decline in profit margins. The most recent Stats SA’s Quarterly Financial Statistics (QFS) Survey, which analyses a range of financial measures among formal businesses, found that the average South African business’s profit margin has shrunk to 5%. This means that the average business only pockets 5c profit for every R1 of sales.

As is the case with the return on assets, the profit margins are on a downward trajectory and have halved since businesses banked 9c for every R1 of sales prior to the 2009 financial crisis.

The economic sectors that are under the most pressure are also sectors that employ the majority of low-skilled workers in the country. These include the retail, manufacturing and mining sectors, where (in the former two) profit margins are below 3%. In the mining sector margins are -7%.

Another interesting metric, showing the immense pressure business owners face, is the decline in dividend payouts as a percentage of total employee costs. In many circles profit is seen as a synonym for labour exploitation. StatsSA data shows that in 2011 total dividend payments to shareholders amounted to 15% of total employee costs. Since then, this ratio has steadily declined to hit a record low of 8% in the first quarter of 2016.

“This means that for every R1 paid towards salaries and wages of employees, the average business owner gets paid 8c,” says Schüssler. “This is nearly half the 15c they received in 2011. This declining trend is also worrying and shows that business owners are absorbing much more of the economic downturn than workers.”

When labour gets expensive and costly; retrenchment becomes more likely. But what is already obvious in the employment numbers, is that the private sector has stopped expanding employment. The number of private sector workers is now about the same as it was in 2003, and certainly less than in 2007.

This has led to higher unemployment because the growing population has not been absorbed into the job market. “This effect increases the risk for South Africa as the stagnating economy with broad unemployment of nine million is likely to increase to over ten million soon,” says Schüssler

Schüssler notes that “higher risk leads to the need for higher returns in the country, while low returns have become the norm.” The trend is becoming self-reinforcing and business leaders and shareholders have noticed, with even small firms eyeing investments outside of South Africa.

Is this why Cosatu is now more willing to talk about entrenched employee privileges?

The reality is that South African businesses are under immense pressure and any proactive programmes for job creation need to start to improve the financial position of these companies.